So I was offered an investment in a mid cap company. They were seeking £600K for an 8% investment in their holding company. The money was going to be split, with £250K for working capital and £350K to pay outstanding debts. The working capital requirement I could understand, but I wanted to know more about the £350K loan.
I was told it was taken out by the founder to buy out other investors after a disagreement on the companies future direction. So in fact the £350K was not going to the company, but the founder to pay a personal debt.
So with a self proclaimed valuation of £7.5M I started to research the company in more detail. I didn’t like what I saw, it was a holding company with minor interests in a few subsidiaries. It did do some of its own trading, however, based on trade alone it was insolvent. So I looked into the minor shareholdings. Now, strictly speaking you should not include minority shareholdings in valuations, as, without control, the asset can be volatile and uncertain. I was however, prepared to look favourably in an attempt to find some value to negotiate a deal.
To my chagrin, the two largest subsidiaries were both themselves burning cash and while not yet insolvent, would be within 1 to 2 years. So with assets approaching £500K, a trading valuation of £0, and very little goodwill or intangible assets, I contacted the founder and explained I could not invest in his company.
About a week later, he contacted me again and asked if we could meet. As I was going to be in London anyway, I agreed and met him at my offices. He explained that he had been unable to raise sufficient funds and that his personal loan was about to come overdue and he was facing EXTREMELY severe penalty clauses. He asked if he could borrow the money from me on a short term ultra high interest loan. I explained that, I could and have acted like a bank in the past and would be amenable to this again to help him out. I would however require sufficient collateral.
At first he offered his apartment, but it soon became clear that an existing charge against this rendered it valueless, so we looked at other options either within the business or through his family.
Before this was completed, he fortunately (for him) found a last minute investor and was able to replace his short term debt for long term equity release.
Why am I telling you this? Because, I was shocked and horrified, I couldn’t possibly condone anybody to work like that, although I am aware some extreme risk takers spend their entire lives doing just that.
In most businesses, some leverage is good and even necessary and options such as bank overdrafts or favourable long term loans can be useful. However I couldn’t get involved with any company founder that gambles to that extent.
If you are seeking investment to service high levels of debt, please go elsewhere, thank you.